Gazprom—the LNG pivot?
Faced with growing domestic competition and a wave of seaborne gas heading for Europe, Gazprom needs to up its own LNG game
The title of a 7 August report from S&P Global Ratings, Can The US Shut Off Russia's Gas Supply To Europe?, was eye-catching, but a little over the top. It did, though, exemplify some of the problems facing Russia's state-controlled gas-export firm.
S&P was reflecting the latest round of sanctions signed (reluctantly) on 2 August by US President Donald Trump. Among other measures, they introduced new sanctions on entities involved in Russian offshore oil projects and those participating in Russian oil or gas pipe-line construction.
Gazprom has always insisted that the "Western sanctions have left [it] largely unaffected… and had little bearing on the company's ongoing activities". Still, it is getting harder and costlier for the state company to build its three big new gas-export pipelines—Nord Stream 2 and Turkish Stream, both bound for European markets; and the Power of Siberia project to serve Asia.
"S&P Global Ratings currently believes that if, as a result of new sanctions, Gazprom needs to fund new pipeline construction on its own, the company can absorb the financial impact without damaging its creditworthiness," the report's authors, Elena Anankina and Alexander Griaznov, wrote. "But if sanctions caused significant delays or cancellation of new pipeline projects, which is not our base case, this could push up gas prices, heighten the risk of supply interruptions from Russia, and increase usage of underground gas storage and liquefied natural gas."
Despite being a vertically integrated energy company also involved in oil, liquefied natural gas and electricity, Gazprom's lifeblood is still its pipeline gas exports. It maintains an export monopoly over piped supplies from Russia, including to its main market of Europe, which depends on Russian gas to meet about a third of its demand.
Exports to Europe hit a record 179.3bn cubic metres in 2016, generating more than half of Gazprom's annual revenue of R6.11 trillion ($104bn) that year. And 2017 looks strong too: the company announced it set a new record in daily gas export volumes to Europe on 24 August, reaching 0.59bn cm.
"Gazprom has been reporting an increase in export gas volumes since the beginning of the year, with the growth reaching 12% year on year by mid-August," notes Dmitry Loukashov, head of oil and gas at investment firm VTB Capital in Moscow. "High temperatures add to other factors, including the low level of gas in underground gas storages in Europe, which have been driving the growth of Gazprom's exports to Europe. Our model assumes Gazprom exporting 182bn cm of gas to Europe in 2017, up 2% year on year."
If sanctions have stolen the attention, the bigger threat to Gazprom's export business might lie closer to home.
Exports to Europe hit a record 179.3bn cubic metres in 2016
Russia's business daily Vedomosti reported recently that an intergovernmental committee of Russia's Security Council met on 6 July to discuss the future of Gazprom's export monopoly rights—and recommended opening up the trade. Executives from Rosneft and Russian independent gas producer Novatek attended the meeting; no one from Gazprom was there.
Rosneft, under its ruthless, ambitious boss Igor Sechin, has been chipping away at Gazprom's power for years. With Novatek as an enthusiastic partner, Rosneft managed to end the state gas giant's export monopoly over LNG at the end of 2013. Novatek is in the final stages of building its fully financed $27bn Yamal LNG project in northwest Siberia. It should start operating by the end of this year and hit full capacity of 16.5m tonnes a year in 2019. Novatek has plans for two more LNG projects, and Rosneft one. By contrast, Gazprom has delayed indefinitely its two huge LNG developments, Shtokman LNG in the Arctic and Vladivostok LNG on the Pacific coast, while also pushing back by several years two other projects, the expansion of its existing LNG plant on Sakhalin island, the 10m-t/y Sakhalin-2, and the construction of a 10m-t/y, two-train LNG plant on Russia's Baltic Sea coast.
Faced with an onslaught of LNG supplies from global rivals—some targeting Gazprom's main market in Europe—Russia's government feels a reorganisation of its gas-export sector is overdue. As one expert notes, "Moscow needs to take urgent action to turn Russia into a major exporter of LNG".
"Growing ambitions of Rosneft in gas production will likely prompt a growing discussion about structural and legal changes in the organisation of Russian gas market, including the revival of the debate over Gazprom's gas-export rights," says Alexander Burgansky, head of oil and gas at Renaissance Capital. "Gazprom's exports to Europe are the most profitable part of its business, and any indication that these are at risk is negative for the stock."
Gazprom's shares certainly reflect the worries about the company's long-term future. At the end of August the shares were trading around R118, down about 24% in the past year. Gazprom was once Russia's most valuable company, but last year ceded that title to Rosneft, which today has a market cap of $55bn compared with Gazprom's $48bn.
Traders point out that Gazprom stock is incredibly cheap and trades at a trailing price/earnings ratio of 2x; its foreign competitors like ExxonMobil, Total, BP and Shell trade at multiples of 15-30x. "The reasons are almost purely political," says one trader, pointing out that the past 10 years' average net income was $25bn, which is more than half of the current market cap.
The stock may be underpriced, but there seems little let-up in the bad news. Gazprom's latest results, announced on 29 August, showed net income during the first half of 2017 plunged by 37% on year to R381bn because of adverse currency effects. Revenues in the period, though, increased by 4.8% to R3.21 trillion.
Renaissance Capital's Burgansky notes that the company's underlying business performance has steadily deteriorated in recent years—"its cause not helped by its de-facto domestic position as a 'value pump', which has been distributing its economic resources to support the rest of the Russian economy". Meanwhile, its market share in Russia itself is likely to keep falling. Burgansky forecasts it will drop to less than 50% by 2020—a rough outlook, if European exports are about to become less profitable too.
Change in the air
Not all observers are so bleak on Gazprom's future. For one thing, the end to its export monopoly is not inevitable. Despite Sechin's strong influence in the Kremlin, Gazprom's no slouch on the lobbying front. "I deem it unlikely that the transportation monopoly will be broken anytime soon. The most likely outcome would be Gazprom getting paid for transporting other companies' volumes," says Viktor Katona, an oil-supply specialist at Hungary's Mol.
And any end to the monopoly, if it comes, might not be the blow many predict. "Gazprom has realised that it can no longer cling to old pricing and contractual terms," wrote Martin Vladimirov, of the Center for the Study of Democracy, and Sijbren de Jong of The Hague Centre for Strategic Studies, in a recent paper for The Atlantic Council. "Nord Stream II and Turkish Stream should be seen as the last convulsions of a centralised, supply-driven energy policy to capture market share."
Earlier this year, Gazprom also managed amicably to end a potentially damaging European Commission probe into the alleged abuse of its dominant market position in Central and Eastern Europe. The agreed remedies, analysts note, are well-aligned with Gazprom's own interests.
And Gazprom can always fight against new market rivals in Europe by cutting prices. "Already, we've seen that Russia is going to fight for market share: in its public statements, in the fact that it supplied record volumes to Europe at relatively low prices last year and in the fact that it's made moves to deliver more flexible commercial arrangements," says Gary Regan, an analyst at Gas Strategies.
Faced with an onslaught of LNG supplies from global rivals—some targeting Gazprom's main market in Europe—Russia's government feels a reorganisation of its gas-export sector is overdue
Problematic, though, remain the politics. Eastern European countries are generally hostile to Russian influence and see strategic sense in non-Russian LNG supplies. Lithuania on 21 August received its first spot shipment of LNG from the US, for example, and will be prepared to pay over the odds to keep diversifying its supply that way.
So not everything will go Gazprom's way, despite its pricing power. This makes the advancing of its own LNG plans more important. Noting that global LNG supply is expected to increase by 110m-120m t/y in the next five years, Mol's Katona says Gazprom needs to pitch in as soon as possible to avoid entering an oversupplied market in the mid-2020s.
The Baltic LNG project is its best near-term bet. In June, Gazprom and Shell signed the Heads of Agreement to set up a joint venture for Baltic LNG, which will secure financing for and carry out the design, construction and operation of the 10m-t/y, $11.5bn liquefaction plant to be located in Ust-Luga, in the Leningrad Region. Reports in the summer suggested Japan's Mitsui and Itochu Corporation were interested in joining the project too.
To make the project work, Katona says Gazprom will have to ditch its reliance on long-term supply contracts—and avoid cannibalising its pipeline—transported volumes bound for Europe. That means "the sweetest spot" for Baltic LNG would be the UK, which gets almost all its 7.4m t/y of LNG from Qatar. "With a combination of significantly lower transportation costs and pricing flexibility, Doha might see its dominant share narrowed down," Katona reckons.
Conditions for LNG development remain beneficial in Russia—no export duties, and political and financial assistance. So the project might make sense. The main threat, says Katona, is that Novatek moves more quickly and aggressively, leaving no space for Gazprom to secure a market position.
"Gazprom has a couple of competitive advantages. The gas for Baltic LNG would be supplied from the federal gas transmission system, so no need to build costly infrastructure, new cities and airports. But they must act now," he says.